Exam ManagementJames D. Russell, CPAbroker compliance examinations, tips and advice
It is obvious that state regulatory agencies have beefed up
their oversight of mortgage brokers and mortgage bankers. I receive
phone calls from panicked originators each day requesting
last-minute advice on what to do and what to say when they get
notified about their upcoming examination (depending on your state,
your regulator may alternatively refer to the "examination" as an
inspection, assessment or review).
While there are many things that can be done at this point in
the process, we highly recommend that brokers not wait until the
11th hour to develop or fix their compliance program. Ideally, a
compliance program should be a daily part of any broker's
operations. The misconception is that a compliance program is
expensive and time-consuming, but it's not. A little bit of
resources spent today will allow you to sleep better and might
prevent a costly poor examination in the future.
However, if you're the procrastinating type, I have provided
some of the more frequently asked questions that I receive from
brokers who find themselves on the other end of a gut-wrenching
call from a state regulator.
Do I have to agree to an examination?
Yes, you have no choice in the matter. Visit your state regulator's
Web site, which should provide a link to the applicable laws and
regulations that give the regulator the authority to examine your
Why was I selected for an examination?
Several factors are used by regulators to select offices for
examination, including 1) loan volume; 2) sub-prime loan volume; 3)
number of loan officers; 4) loan officer churning; 5) complaints;
6) time period since your last examination; and/or 7) random luck.
With regard to complaints, you will know if you have one since the
regulators are typically required to notify the broker.
What are they looking for?
This is an assessment of consumer compliance, and regulators are
basically interested in your compliance with applicable state and
federal consumer laws and regulations. Basically, they want to know
if you are deceiving or cheating the consumer. These state and
federal laws and regulations were created to insure that a consumer
is 1) given accurate and timely disclosures; 2) charged appropriate
and reasonable fees; and 3) treated fairly in the mortgage
origination process. Examples of consumer compliance issues include
fair treatment of minority applicants and timely delivery of
accurate Good Faith Estimates and Truth in Lending disclosures.
This is not an assessment of underwriting compliance.
Underwriting compliance is concerned with whether the borrower or
originator accidentally made errors, or purposefully committed
fraud in the underwriting process. This is the concern of the U.S. Department of Housing and Urban
Development, as well as your upstream lenders/investors.
Examples of underwriting compliance issues include proper
reflection of the borrower's credit history, income, property
value, etc. Underwriting compliance is often measured by default
rates and HUD/investor quality control reviews. Many originators
believe that sound underwriting compliance automatically means
sound consumer compliance. However, I have seen many instances
where underwriting compliance was very sound, while consumer
compliance was deficient.
What is the process for being notified about an
Typically, the examiner will call the licensed mortgage broker at
least one to three weeks prior to the examination. They will
inquire about the number of loan officers, number of locations,
whether or not the broker keeps an accurate mortgage transaction
log, etc. They will explain that they will look at several closed,
denied and in-process files, attempting to include each loan
officer in the sample. They will indicate that they need to talk to
the broker and compliance officer (if applicable) for about two
hours at the beginning of the examination; they will inquire about
the procedures that are used by loan officers and professors; they
will ask about a working space; and lastly, they will estimate the
time they will spend at your location. Sometimes they will come in
a few days before the actual beginning of the examination for an
initial meeting with the primary licensee and compliance
Make sure you get the examiner's phone number and e-mail
address, just in case you need it either before the exam starts or
after the examiner leaves.
Should I "doctor" my files to get into
No. That would be extremely foolish, and the benefits gained will
not outweigh the risks of "doctoring" the files. First, it's wrong.
Second, you might not be thorough enough to fool the examiners.
Third, the examiners may perform a consumer confirmation, where
they call directly on the consumer to provide copies of their
disclosures to compare with the disclosures in the broker's files.
If the examiners find out that you deceived them, you might as well
look for a new line of work. Lastly, many states have statutes that
provide for prison time for purposefully deceiving a regulator.
Once the examiner has called, can I do anything to
prepare for the examination?
Yes. Fix those things that can be fixed. If you haven't had the
time to call a compliance expert to help "fine-tune" your
operations, now is the time. There are several things they can do
to help, such as reviewing the office signage, counseling loan
officers on how to act, reminding loan officers about certain
compliance issues, and reviewing the mortgage transaction log,
policies and checklists. Some of these things might mean the
difference between a satisfactory or unsatisfactory rating.
If you have the time and expertise, you can perform the role of
the compliance expert yourself. I recommend reviewing the
applicable state laws. Ideally, you should also review the sections
of the Real Estate Settlement Procedures Act's Regulation X that
pertain to mortgage brokers. If necessary, you should also review
the general requirements of other applicable regulations, such as
the Truth in Lending Act's Regulation Z, the Equal Credit
Opportunity Act's Regulation B, the Gramm-Leach-Bliley Act and the
Fair Housing Act.
How should I act?
Act respectful and polite, just as you should with a loan
applicant. Do not be cocky, confrontational, critical or
Examiners are not loan officers, and as such, they do not have
your experience. They were not hired to be loan officers, nor were
they trained to be loan officers. Therefore, there will be many
aspects of your job that are outside of their area of expertise.
However, they probably know a lot more about consumer compliance
than you do. Even so, if you think they might be wrong about a
consumer compliance issue, be polite in your disagreement.
Be honest. Be helpful. The faster you provide them with what
they want, the more organized they will perceive you to be. (Also,
the faster they will leave.) You can joke around if the mood seems
right, but if the examination is not going well, this might not be
a good idea.
The bottom line do not worry too much. Examiners are people just
like you, and they will understand your apprehension.
What if I am going to be out of the office (i.e. on
Talk to the examiner about the situation; chances are, they will be
understanding and willing to change their plans, especially if it
is an unavoidable situation. However, do not expect a long delay.
The best you will get is one or two weeks of extra time that will
most likely be spent worrying about the exam. (There is not much
that you can fix in one or two weeks.) If the examiner is on a
tight time schedule, they might even offer to visit your shop while
you are gone. (If this happens, however, I would postpone your
vacation; you most definitely want to be present to help insure the
examination goes smoothly.)
Should I offer to take the examiner to lunch or
No. They will never accept the offer. The general rule of thumb is
that they can participate in whatever office goodies are available,
such as coffee and doughnuts, but only if they are available to all
office employees. For example, if a lender happens to already be
providing lunch, you could offer that to the examiner.
What happens at the end of the
They will have a wrap-up meeting to discuss the findings, where
they will provide you with a list of possible violations. Don't be
defensive. I recommend verbally acknowledging any issues that they
have found and assuring them that you will work on getting things
right. Or, if appropriate, ask for their help or advice on how to
best resolve the issue. If there are any glaring errors on the part
of the examiner, you can try to respectfully indicate the error.
For example, if they indicate that the licenses are not posted in
the lobby, you could apologize for the oversight and indicate that
they are hanging in each loan officers' office.
Some violations will take a little time to research (such as a
missing GFE). For these, I recommend doing the research as soon as
the examiner leaves. Then, if the examiner made a mistake or
overlooked a disclosure, you can send them the new information. You
can ask, but they probably will not tell you the final rating.
However, they might give a range or indicate whether you should be
At the conclusion of the meeting, be respectful and polite, and
thank them for their visit.
What if I have violations?
I have never reviewed a perfect file, and I have never seen an
Examination Report with no violations. Every examination has some
How am I judged?
You will receive a written report within six to eight weeks. (The
time lag comes from the necessity to send all reports to regulators
home office for a supervisor's review.)
Included in the report will usually be some type of grade, which
may be a range of numbers (i.e. "1" being excellent and "5" being
bad) or a descriptive word ("excellent," "satisfactory,"
"unsatisfactory" etc.). The grade will usually include a narrative
description of the rating.
Whatever your state's grading system, the only important
consideration is whether you were above or below the minimum
acceptable level of compliance. If you were below the minimum, you
can expect a follow-up examination within the following several
months. If you were significantly below the minimum acceptable
level of compliance, you can also expect some sort of enforcement
action. You should immediately call a compliance expert or an
What do you mean by enforcement action?
Enforcement actions differ from state to state. Less severe
enforcement actions might include an "agreed order" or "resolution"
where the mortgage originator agrees to conform to certain
requirements provided by the regulator. In these situations, a
follow-up examination will review the compliance with the order. If
the originator is in non-compliance with this more lenient order,
the originator can expect more severe enforcement action.
One of the most severe enforcement actions in most regulators'
arsenals is a Cease and Desist Order. This is typically reserved
for those situations where the regulator believes that you have
either 1) financially harmed the consumer; 2) denied the consumer
the ability to shop the loan by providing deceptive disclosures; or
3) grossly disregarded consumer compliance.
A Cease and Desist Order is a legal action taken against a party
to prohibit that party from doing or continuing to do a certain
activity. The order includes a determination by the regulators that
you have done something wrong and that you must stop doing certain
things. The Order can range from having to cease operations, to
having to cease providing incorrect disclosures. Oftentimes, an
Order will require that you implement a compliance program or hire
an independent consultant to conduct quarterly compliance reviews.
Sometimes, Orders will require you to pay a fine to the government
and/or to reimburse customers. The repercussions do not end. The
regulator will eventually publish your Order, and your
lenders/investors may balk at doing business with you.
If you get the sense that you are in this category, immediately
call a compliance expert and/or an attorney. If you were unaware
that you were in this category until you received your final report
from the regulators, do not bury your head in the sand. Get
compliance and legal representation. There is much that can be done
to either mitigate or contest the Cease and Desist Order.
What if they are not fair?
First, it has been my experience that the examiners are fair
especially examinations that have been conducted in 2003 and
beyond. Second, and as indicated earlier, all reports go to the
home office for a review. All examinations receiving a bad rating
will receive a close review by the home office. If you still think
they were not fair, call a compliance expert or attorney to discuss
the situation. There are several things that they can do to either
mitigate the poor results or contest the examination.
Can I do anything after they leave?
Fix everything that can be fixed! If they discussed the need to put
your license number on your Web site, fix it. If they want you to
setup your software default settings, fix it. If they want you to
change your procedures to hand out HUD's Settlement Cost Booklets
at application, fix it.
Some things cannot be fixed such as missing or inaccurate
consumer disclosures. Do not worry about these types of violations
since they are unfixable. However, you should change office
procedures so that this type of violation is not repeated.
As indicated earlier, review the files for any possible errors
that the examiners might have made. The examiners are not used to
your file system and might have overlooked one or more
Respond to the examination as quickly as possible (ideally
within one or two days) to try to influence the examiner before
he/she sends the report into the home office. (I recommend e-mail
since snail mail might take weeks to get to the examiner.) Once the
report is sent to the home office, the examiner is put into the
position of having to defend his/her work to a supervisor. Also, a
quick response shows the examiner that you really cared about
making the corrections.
If the examination has been adversarial and you are anticipating
a poor rating, I do not recommend any formal correspondence until
you have hired a compliance expert or attorney.
What should I do when the report comes back to
If the rating is satisfactory, you can have a party and pat
yourself on the back for a job well done. Also, write a
complimentary letter to the home office, being sure to mention all
the positive things about the examiner. Not only is this a nice
thing to do, but you might be examined by this regulator in the
future, and he/she is likely to remember your kind words.
If the rating is marginal, carefully review the report and make
the necessary changes to ensure the same issues do not surface on
subsequent visits or examinations. If these same issues resurface
at a subsequent examination or visit, you can certainly expect a
If the rating is unsatisfactory, do not acknowledge anything to
the regulatory authorities until you have hired a compliance
consultant or attorney. You are now in a fight for your
James D. Russell, CPA is the managing partner of Austin,
Texas-based Broker Compliance. He may be reached by phone at (512)
328-1777, by e-mail at firstname.lastname@example.org
or visit www.brokercompliance.com.